What Can Warren Buffett Teach Us About Cyprus?

Warren Buffett has offered a lot of timeless wisdom to investors over the years. Considering the recent turmoil in Cyprus, now is a good time to review a fellow named Mr. Market.

The Oracle of Omaha and chief executive officer of Berkshire Hathaway (NYSE:BRKA) (NYSE:BRKB) makes regular appearances on television, but his annual letters to shareholders still provide the biggest bang for your buck. In the 1987 letter, Buffett introduces readers to Mr. Market, a character that came into Buffett’s life from his teacher and the father of value investing, Benjamin Graham. Mr. Market is the mental attitude towards market fluctuations. He is reliable in the sense that he appears daily to provide market quotations. However, his mood is anything but reliable.

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If Mr. Market was a real person, he would have a prescription for every bipolar pill under the sun, and it still wouldn’t be enough.

Buffett explains, “The poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.”

Since the March 2009 bottom, Mr. Market has been very focused on only the good. In fact, the rebound in stocks is often referred to as the most-hated rally in history. Growth and unemployment concerns have been tossed aside in favor of Federal Reserve easing, apparently Mr. Market’s favorite medicine. Nonetheless, doubt is beginning to rise.

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It is too early to tell if a larger pullback is underway, but stocks are feeling less certain about themselves than they did just a couple weeks ago. Cyprus stepped into the spotlight earlier this month by deciding to confiscate bank deposits to satisfy requirements for a bailout from international leaders. The small island in the Mediterranean Sea allowed its banking system to grow to roughly eight times gross domestic product, and now finds itself insolvent amid the euro-zone financial crisis. The decision to seize insured bank accounts with under 100,000 euros was ultimately reversed, but the damage is already done. Banks in the country have yet to reopen.

When confidence is lost, it can be extremely hard to regain. With capital controls and contagion fears spreading, Mr. Market appears to be turning a bit more cautious. Last week, the Dow Jones Industrial Average (NYSEARCA:DIA) finished in the red to break its four-week winning streak, while the S&P 500 (NYSEARCA:SPY) continues to struggle with making new all-time nominal highs. The decline is not even a blip in the bigger picture, but it is a clear contrast to pre-Cyprus movement.

One of the most important things to remember about Mr. Market is that you can ignore him. If the Cyprus situation is causing too many unknowns for you, take a step back.

Buffett writes, “He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you. But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence.”

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Even though central banks around the world are devaluing fiat currencies, the mantra that “cash is king” is still relevant. Cash on the sidelines should never be underestimated. If you are fully invested, you are unable to take advantage of the dramatic mood swings of Mr. Market. Buffett enjoys a good deal as much as the next guy, but he has pledged to keep a cash reserve of at least $10 billion to both withstand unprecedented insurance losses, and take advantage of Mr. Market.

The Cyprus situation, macroeconomic issues, and market intervention by central banks are tugging Mr. Market left and right. With volatility near multi-year lows, the mood swings are likely to increase in the future. However, if you don’t like the prices coming from Mr. Market, there is always tomorrow.

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